Deduction limits where ESOP is combined with 401(k)

[Belgarath]

This is a case where the regs seem clear, (to me) but third party write-ups seem less clear, and I'd like to confirm that I'm not missing anything.

This is an S-CORP leveraged ESOP, and the employer also sponsors a 401(k). So you have the general 404(a)(3) limit of 25% of comp. The increased deduction limit under 404(a)(9) specifically does not apply, as per paragraph (C) of 404(a)(9).

Some of the write-ups appear to say that you could deduct up to 25% of eligible compensation on principal repayments of an exempt loan in the same year you take a deduction under 404(a)(3) for contributions to the non-ESOP 401(k), as long as you comply with 415.

Am I missing something?

[ESOP Guy]

I don't think an S Corp can take both.  As you say the paragraph (C) precludes the extra principal and interest deduction. 

I have seen C Corps take some huge deductions well over 25% while staying within 415 this way but not S Corps. 

(9) Certain contributions to employee stock ownership plans

(A) Principal payments

Notwithstanding the provisions of paragraphs (3) and (7), if contributions are paid into a trust which forms a part of an employee stock ownership plan (as described in section 4975(e)(7)), and such contributions are, on or before the time prescribed in paragraph (6), applied by the plan to the repayment of the principal of a loan incurred for the purpose of acquiring qualifying employer securities (as described in section 4975(e)(8)), such contributions shall be deductible under this paragraph for the taxable year determined under paragraph (6). The amount deductible under this paragraph shall not, however, exceed 25 percent of the compensation otherwise paid or accrued during the taxable year to the employees under such employee stock ownership plan. Any amount paid into such trust in any taxable year in excess of the amount deductible under this paragraph shall be deductible in the succeeding taxable years in order of time to the extent of the difference between the amount paid and deductible in each such succeeding year and the maximum amount deductible for such year under the preceding sentence.

(B) Interest payment

Notwithstanding the provisions of paragraphs (3) and (7), if contributions are made to an employee stock ownership plan (described in subparagraph (A)) and such contributions are applied by the plan to the repayment of interest on a loan incurred for the purpose of acquiring qualifying employer securities (as described in subparagraph (A)), such contributions shall be deductible for the taxable year with respect to which such contributions are made as determined under paragraph (6).

(C) S corporations

This paragraph shall not apply to an S corporation.

[Belgarath]

Thanks.

[A Shot in the Dark]

It is not uncommon for an "S" Corp ESOP to use the full 25% (404(a)(3)) limit for the principal payment and simply not deduct the interest.

Chances are the "S" Corp ESOP may not need the interest tax deduction.